September's Rate Hike Won't Be the Last

September 19, 2004

By Kim Rupert and Michael Wallace Will it be a matter of "one-and-done" for Alan Greenspan & Co. at its Sept. 21 policy meeting? Since a quarter-point rate hike at the

Federal Open Market Committee meeting on that date seems a fait accompli, the markets will instead focus on the tone of its post-meeting policy statement. While some observers are speculating that the FOMC will hint at a more tempered policy trajectory -- perhaps signaling a pause in its series of rate hikes -- we at Action Economics don't expect any significant changes to the policy language.

Instead, apart from the widely expected rate hike, look for the Fed to reiterate that the current stance of policy remains accommodative and that the FOMC can remove accommodation at a "measured" pace. That will be a signal that its work is not yet done and for investors expect another rate hike in November, barring any unforeseen events that cause shocks to the market or the economy.

"ROUGHLY BALANCED." How might the central bank assess current economic conditions in the statement? Greenspan downgraded inflation risks in his recent House testimony, so the statement should reflect that view. Also, look for a Fed upgrade on the economy as the recovery "gains traction." Greenspan & Co. may acknowledge in the opening paragraph of its policy statement a pickup in growth relative to the Aug. 10 statement, which would be consistent with further rate hikes down the road.

And with recent August data in hand -- including the improvement in employment and the tame readings on inflation don't expect any change in the "roughly balanced" assessment on the economy and prices as seen in the August statement.

At its Aug. 10 meeting, the FOMC voted unanimously to hike the Fed funds target rate by one-quarter percent, to 1.50%, to no one's surprise. The fact that the Fed still believes money is cheap and that factors outside of typical economic inputs caused much of the recent "soft patch" suggests to us that policymakers remain on their intended course.

DON'T BET ON IT. The solid August jobs report certainly keeps the Fed on track for a quarter-point hike at the September meeting. However, a benign outlook on inflation from Chairman Greenspan in recent testimony before a House budget panel and tame August data on consumer and producer prices have increased market expectations for at most a 2% Fed funds target at yearend, with many traders now saying the central bank may end the current tightening cycle with the Sept. 21 hike.

Wishful thinking, in our view. The key to the FOMC's rate-hike trajectory will be what it considers "neutral" policy -- the level at which interest rates are neither too accommodative nor too restrictive -- and how quickly it decides to get there. We expect the Fed will want to see at minimum a 2% yearend target, if not 2.25%, considering the possibility of third-quarter gross domestic product hitting a 4.5% growth rate, as we at Action Economics are forecasting. Rupert is managing director of global fixed-income analysis and Wallace global market strategist for Action Economics